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The Fed Model: The Bad, the Worse, and the Ugly

29 Pages Posted: 21 Jan 2006  

Javier Estrada

IESE Business School

Date Written: January 2006

Abstract

The negative relationship between stock market P/E ratios and government bond yields seems to have become conventional wisdom among practitioners. Both limited empirical evidence and a misleading suggestion that the model originated in the Fed are used to support the model's plausibility. This article argues that the Fed model is flawed from a theoretical standpoint and reports evidence from 20 countries that seriously questions its empirical merits. Despite its widespread use and acceptance, the Fed model is found to be a failure both as a normative and as a positive model of equity pricing.

Keywords: Fed model, P/E ratios, cointegration, earnings yields

JEL Classification: G11, G12

Suggested Citation

Estrada, Javier, The Fed Model: The Bad, the Worse, and the Ugly (January 2006). Available at SSRN: https://ssrn.com/abstract=877245 or http://dx.doi.org/10.2139/ssrn.877245

Javier Estrada (Contact Author)

IESE Business School ( email )

IESE Business School
Av. Pearson 21
Barcelona, 08034
Spain
+34 93 253 4200 (Phone)
+34 93 253 4343 (Fax)

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